Abstract

I. Introduction There is widespread evidence that the volatility of equity returns is higher in bull markets than in bear markets. One potential explanation for such asymmetry in variance is the so‐called ‘leverage effect’ of Black (1976) and Christie (1982) . As equity values fall, the weight attached to debt in a firm's capital structure rises, ceteris paribus . This induces equity holders, who bear the residual risk of the firm, to perceive the stream of future income accruing to their portfolios as being relatively more risky. An alternative view is provided by the ‘volatility‐feedback’ hypothesis. Assuming constant dividends, if expected returns increase when stock return volatility increases, then stock prices should fall when volatility rises. Pagan and Schwert (1990) , Nelson (1991) , Campbell and Hentschel (1992) , Engle and Ng (1993) , Glosten, Jagannathan and Runkle (1993) and Henry (1998) , inter alia , provide evidence of asymmetry in equity return volatility using univariate GARCH models. Kroner and Ng (1996) , Braun, Nelson and Sunnier (1995) , Henry and Sharma (1999) , Engle and Cho (1999) and Brooks and Henry (2000) , inter alia , use multivariate GARCH models to capture time variation and asymmetry in